As state legislative sessions are coming to an end around the country, state policymakers have faced budget deficits due to the coronavirus pandemic. To fill their budget deficits, some have argued that policymakers should consider taking away defined-benefit pensions for future employees and enrolling them in defined-contribution accounts like 401(k)s instead. 

But what are the consequences of implementing this decision for public employees’ retirement security and state and local governments? 

This week, we released a new report in partnership with our state coalition in Wyoming, the Wyoming Coalition for a Healthy Retirement (WCHR), that seeks to answer these questions and more. The report, entitled,  Fiscal Responsibility and 401(k)s: Why Converting Public Employees to Defined-Contribution Retirement Plans is Wrong for Your State, examines the potential impacts of converting pensions into defined-contribution 401(k) accounts. 

The Wyoming Retirement System (WRS), which serves nearly 80,000 active and retired public employees across Wyoming, is well-funded and healthy. According to the National Institute on Retirement Security, the spending of the state’s retired public employees supports $891.5 million in total economic output, 5,521 jobs, and generates $129.4 million in federal, state, and local tax revenue. That’s real money having a positive impact on local communities across the state.

Additionally, according to WRS’ 2020 annual report, Wyoming has the lowest contribution rate in the nation at 1.98% of state and local budget expenses, compared to the national average of 5.2%.

You can read the full report here, but three important takeaways include: 

  • Closing defined-benefit plans can lead to higher costs for states by cutting off a source of future revenue. 

Several states have previously thought they could save costs by eliminating defined-benefit pensions. However, research shows that costs had increased for states when they made the switch. 

In Michigan, for example, the state halted access to the State Employees’ Retirement System (SERS) in 1997. When the state closed the plan, it was in excellent fiscal shape, with a funded status of 109% and excess assets of $734 million. By September 2019, the plan’s funded status had dropped to 64.7%, and it had an unfunded liability of $6.6 billion. 

By closing the plan to newly hired public employees, the state lost a significant portion of its future revenue for the plan, creating higher costs for SERS in the long run. 

In West Virginia, policymakers made a similar decision with the state’s Teacher Retirement System (TRS) by closing it to newly hired educators in 1991. By 2005, the plan’s funded status had decreased to 25%. That same year, the state re-opened TRS when it found that it could provide equivalent retirement benefits at half the defined-contribution plan’s cost. After giving educators the choice to switch back to a defined-benefit pension, more than 78% of them chose to do so. 

These two states’ experiences show that 401(k)s are not the cost-saving measure states sometimes think it is. 

  • Not offering a defined-benefit pension makes it more challenging for states and local governments to recruit and retain public employees. 

Some jurisdictions have also experienced difficulties recruiting and retaining qualified public employees after they closed their defined-benefit plans. For example, the Town of Palm Beach, Florida, stopped offering a defined-benefit plan to newly hired public safety officers in 2012. Afterward, the town’s training costs jumped to almost $20 million because officers would train in Palm Beach and leave to work in neighboring areas that offered a defined-benefit plan. 

During the same year that West Virginia re-opened TRS, the state of Alaska went in the opposite direction and closed both the Public Employees Retirement System (PERS) and its pension plan for educators. Like Palm Beach, it also experienced similar recruitment and retention issues, with high teacher turnover rates costing the state $20 million per year. The Alaska Department of Public Safety Recruitment and Retention Plan Overview for 2018-2023 also outlined that the lack of a defined-benefit plan affected staffing levels for State Troopers, with its report stating that “the budget climate, reduced resources, inadequate wages and the inability to provide a defined benefits retirement system have placed the department at critically low staffing levels.” 

  • 401(k)s have exacerbated the retirement security crisis. 

Following the Revenue Act’s passage in 1978, defined-contribution plans such as 401(k)s slowly became the primary retirement plan for private-sector employees. According to the report, “in 2018, 51% of private-sector employees were offered a defined-contribution plan, 13% were offered a defined-contribution and a defined-benefit pension plan, and 4% were offered a defined-benefit pension plan solely.” 

401(k)s have made it more difficult for Americans to save for retirement. The Economic Policy Institute has found that nearly half of families have no retirement savings and that the median defined-contribution account balance for households nearing retirement is $21,000, which is not enough to retire with security. 

The current economic downturn has only increased the struggles of saving for retirement, especially for low-income workers who face higher unemployment rates. Because of this, they are often forced to stop saving for retirement and/or withdraw from their retirement savings to make ends meet. 

Evidence continues to show that switching public employees to 401(k)s will not help state and local governments with their budgets. Instead, they can practice fiscal discipline by making their contributions to the pension funds they oversee, just like public employees do with each and every paycheck. 

Thankfully, most public employees still have access to a defined-benefit pension, which guarantees security in retirement. If they had 401(k) accounts instead, chances are they would face similar levels of retirement insecurity as those who work in the private sector.